Work out terminal value for a DCF (discounted cash flow) model with several stages from price multiples and explain this use
The idea
In a multistage discounted cash flow model the terminal value can be set by applying a multiple to a forecast of the relevant fundamental at the horizon, for example TV = P/E × expected EPS or EV/EBITDA × forecast EBITDA. The terminal value is then discounted to today with the other cash flows. A multiple taken from comparable companies is grounded in the market, but if the peers are mispriced the error enters the valuation. A justified multiple from the constant-growth model is consistent with the discount rate but depends on the growth assumption. Timing must match: a trailing multiple is applied to year n earnings, a leading multiple to year n + 1 earnings, and both give a value at year n.
In the app: 1 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Market-Based Valuation: Price and Enterprise Value Multiples
- Contrast comparables with forecasted fundamentals as ways of applying price multiples when valuing, and set out the economic logic behind each
- Work out a justified price multiple and explain what it means
- Set out why one might value a stock with dividend yield or alternative price multiples and what can go wrong
- Work out dividend yield and alternative price multiples and explain what they mean
- Work out underlying earnings and explain them, set out ways to normalise earnings per share (EPS), and compute normalised EPS
- Explain earnings yield (E/P) and argue for its use
- Set out the fundamentals that drive dividend yield and alternative price multiples
- Use a cross-sectional regression on fundamentals to predict a P/E, explain the result, and explain where such regressions fall short
- From forecasted fundamentals, work out a stock's justified price-to-earnings (P/E), price-to-book (P/B) and price-to-sales (P/S) ratios and explain them
- Work out the PEG (P/E-to-growth) ratio, explain what it means and how it is used in relative valuation
- Judge from comparisons of multiples whether a stock is priced too high, too low or fairly
- Assess a stock with comparables and explain why fundamentals matter when applying that method
- Explain the various cash flow definitions used in multiples of price and of enterprise value (EV) and where each falls short
- Work out EV multiples, explain what they mean and assess how useful EV/EBITDA is
- Explain why valuation comparisons across borders can differ
- Explain momentum indicators and how they are used in valuation
- Explain how the median, arithmetic mean, harmonic mean and weighted harmonic mean summarise the typical level of a set of multiples